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The last date to file for income taxes for 2020 is fast approaching. Each of us has been dutifully mentioning every spend and expense we have had in the previous year to make our taxable income as little as possible. However, there is one lingering question in a lot of people’s minds, “Does the government tax car accident settlements?”
The car accident settlements that are given as compensation for causing you physical, emotional, and/or financial damages are not classified as income or wages by the IRS. Logically speaking, your car accident settlement shouldn’t be taxed. However, there is always a grey area that you need to double-check.
The IRS has released a set of guidelines for car accident settlements and other personal injury settlements. Under Publication 4345, Rev. 4-2019, if you do not take a deduction for medical expenses for physical injuries settlements, you are exempt from paying taxes on those amounts. However, if you previously took a tax deduction from that settlement, you can do so now. Any compensation you receive has to be proven to be related to a physical injury such as medical expenses or lost wages.
The compensation for income and wage loss in car accident settlements are taxable. This is because, of the total settlement you win, some of that money is earmarked for physical injury and the other for the lost wages. The IRS’s logic is since if you hadn’t been in an accident, you would have paid the taxes on these lost wages, and hence you should pay them now.
It is advisable that you go to a lawyer and determine exactly how much was earmarked for lost wages in your settlement amount. Then, declare only that amount as your income and pay their taxes.
If you’re a business person and have received settlements towards loss of business revenue, the portion of the settlement contributed to the carrying on the trade or business is subject to the net earnings made from the business, and hence, it is subject to the self-employment tax.
All these proceeds that are taxable as such must be mentioned in the “business income” section on line 21 of form 1040, schedule 1. Again, these proceeds are also mentioned on line 2 of section SE in the same form. If it is confusing to you, the best course of action would be to reach out to a lawyer and find out what portion of the settlement is allocated to what requirements you have and a chartered accountant to help you file them appropriately.
As mentioned above, the IRS does not require you to pay takes on compensation for physical injury. This includes mental and emotional injuries as well. However, if your compensation was partly for non-related distresses, you might have to pay taxes on them as well. So, once again, it would be a good idea to get a lawyer to classify each amount for each category paid to you.
Damages such as punitive damages and other special damages that are slapped on the wrongdoing party for being so reckless that the court decides to punish them further by rewarding the victim do not come under physical damages or personal injuries. Hence, the IRS deems it necessary to pay taxes on these as well. These are to be declared as “other income” in line 21 of form 1040, schedule 1.
Any interest you earn on your settlements must be included in the taxable income and written as “interest income.” This interest income is generally declared in line 2b of form 1040 of your IRS income declaration form.
Some settlement receivers may need to pay “estimated tax payments” if they expect their settlement to be over $1000.
If, unfortunately, you have experienced a car accident in any way in 2020 and are now unsure how much of it is taxable, it is best to find a lawyer that has enough experience to make sure you only pay what you owe and not more. It is always a good idea to have a professional do the work if you have any questions. All forms and publications about filing your taxes are readily available on the official website of the IRS at www.irs.gov.
For any assistance and help regarding car accidents and if car accidents settlements are taxable or not, contact us today. Speak to our expert attorneys and get your doubts sorted. Talk to us today to learn more.
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